November 2008
Beginner
448 pages
11h 33m
English
Content preview from Budgeting Basics and Beyond
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20.8. Nondiscretionary Projects
Some investments are made because of necessity rather than profitability (e.g., pollution control equipment, safety equipment). Here there will be solely a negative cash flow. Hence, discretionary projects must earn a return rate in excess of the cost of capital to make up for the losses on nondiscretionary projects.
Example 18
A company's cost of capital is 14 percent and $30 million of capital projects, 25 percent of which are nondiscretionary projects. It thus has to earn $4.2 million per year (14% × $30 million). The $22.5 million of discretionary projects ($30 million – 25%) must earn 18.7 percent ($4.2 million/$22.5 million) rather than 14 percent to achieve the overall corporate earnings goal of $4.2 million.
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